Budget: The big idea? Better accounting for devolution

As Philip Hammond makes the final adjustments to his budget statement Tom Lawrence argues for a new public finance regime that gives councils greater freedom to borrow for investment.

The chancellor is looking for a “big idea” for his budget – at least according to The Times last month. In recent years, the government has promised us a “devolution revolution”. That is certainly a big idea.

Some parts of government are now starting to realise that they are not in the best position to solve the individual problems faced by every neighbourhood. They are much more likely to be solved by these neighbourhoods themselves and their elected local representatives.

For example, stimulating a local economy and making it more productive will require a bespoke package of measures based on detailed knowledge and experience of its specific features.

We have seen policies enacted which take us down this path—more than 16 million people in England are now covered by devolution deals; over half of the money spent by local councils on general fund services in 2015-16 was raised from a combination of local taxes and local fees, charges and sales (excluding schools grants and rent allowances and rebates) and this proportion is set to rise.

It would, however, be stretching language to describe this as a “revolution”. Will the chancellor take the measures in this budget to turn this idea into a revolutionary change? If he commits to the proposals in this post, maybe. If you’re reading this post after the budget and this hasn’t happened—well, it’s not too late to engage with him.

Localism

Localist thinking has yet to permeate Whitehall. This is best demonstrated in the budget itself. It associates a departmental expenditure limit (DEL) and an annually managed expenditure (AME) with each department. But these are not just figures for central government—they cover the whole public sector.

For example, when a local authority borrows money to improve an asset, at the moment at which the money is spent, this is added to AME. This is true regardless of whether it borrows from the Public Works Loan Board (PWLB) or from a third party, such as a local building society.

All DEL and AME contribute to the government’s main deficit and debt measures, public sector net borrowing (PSNB) and public sector net debt (PSND). The government is therefore presenting all its local government creditors’ debts as its own—even when they are debts to another lender.

Through the fiscal rules, this means the government is setting its budgetary discipline using figures for the whole public sector. This may have been logical during the regime of credit approvals, but looks anachronistic in an era of growing financial autonomy for local government. (Were budgets and spending review documents to recognise the independence of local authorities and their accountability to their own electorates, they might be laid out a bit more like Denmark’s Budget Outlook. Throughout this document, it is clear when the figures being discussed relate to central government, when they relate to general government and when they relate to local government, and some sections focus solely on central government.)

This is not just a presentational issue—it has consequences, through the fiscal rules. Each time a significant financial freedom is granted to local authorities, there seems to be some kind of caveat or constraint placed on capital expenditure. Even when there was the greatest improvement in the capital finance system for local government, the introduction of prudential borrowing in 2004, it included a reserve power for the government to place limits on the total amount of borrowing across England.

More recent changes have had more immediate constraints. When the housing revenue account (HRA) was reformed, caps were put on borrowing for investing in housing. When business rate retention was introduced, councils could apply to the secretary of state to have one-off, unavoidable and otherwise unaffordable revenue costs treated as capital—but such capitalisation had a national limit of just £100m and came at the expense of revenue support grant being cut. This emergency mechanism has now been abolished.

In addition, councils could not prudently engage in tax increment financing (TIFs)—borrowing for investment on the assumption of future growth in business rates—unless the project were exempt from resets and the levy. Such New Development Deals were limited to £150m in 2012 and only three went ahead.

Accountability

While reforming the government’s primary debt and deficit measures is crucial to freeing up local investment, it is too simplistic to focus exclusively on these quantities. After all, countries can have outwardly similar deficit measures and still have different fiscal control regimes and ways of funding local authority capital expenditure.

Any such reform should be based on principles of local democratic accountability, not just a desire to build more. The importance of this is clear from the fact that a narrow focus on keeping public works from contributing to the deficit lay behind the unsuitable use of PFI for many projects in the last decade.

It should also allow councils greater freedom to invest not just in social housing but also in other asset classes. While there is a pressing need for more housing, local business growth and supporting infrastructure are also crucial to creating sustainable communities.

Any resulting borrowing must be undertaken prudently. The tried-and-tested prudential regime seems a good guarantor of this. We shouldn’t expect a surge to make use of new freedoms, but they could be very useful in unblocking small numbers of important projects which would not otherwise be viable.

To provide a sense of scale, Centre for Cities projected that even if England’s 56 cities were to launch a TIF project the size of that undertaken by Edinburgh—an “unrealistic prospect”—the total annual revenue commitment to service the resulting debt would be just £440m. “This would increase public sector debt by less than 0.5% and represent just two percent of England’s current annual business rates revenues…”*

If the chancellor really wants to be “imaginative” and “think big” on investing for growth and unlocking the potential of every neighbourhood, he needs to grasp this issue. He doesn’t need to spell out the detail now, but he does need to commit to a timetabled programme with clear objectives, based on sound principles.

The Treasury is perfectly capable of orchestrating a reform of the public finances—previous reforms such as the Clear Line of Sight programme and the change from the public sector borrowing requirement (PSBR) to PSNB (public sector net borrowing) demonstrate this. However, it would be wise to work through the detail with all parties affected by this reform, to avoid unforeseen hitches.

There would be considerable advantage to the Treasury in instituting such reform. Focusing on central government expenditure would reduce uncertainty in meeting fiscal targets. It would also reduce the need to broker individual deals with authorities looking for capital freedoms, cutting calls on ministers’ and civil servants’ time.

So, Mr Hammond, please seize this opportunity to bring the public finances into the 21st Century.

Dr Tom Lawrence was until recently a briefings author for the Local Government Information Unit on local government finance.

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